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These 2 Oil Stocks Surged This Week, But 1 Still Looks Tempting

Even after this week’s pop, the valuation remains quite compelling.

Shares of Halcon Resources(NYSE:HK) and Enbridge Energy Partners(NYSE:EEP) rallied sharply this week. Halcon Resources, a Permian Basin-focused shale driller, spiked on Thursday -- and was up more than 9% for the week -- after OPEC said it would extend its current production reduction agreement through the end of next year. Meanwhile, oil pipeline company Enbridge Energy Partners bounced nearly 17% for the week after unveiling its guidance for 2018 and beyond.

When stocks make big moves like that, it can be easy for investors to think they have missed out. However, after drilling down a bit deeper, it's clear that Enbridge Energy Partners still has plenty of fuel left in the tank to continue going higher.

Image source: Getty Images.

Fueled by hope

The reason Halcon Resources' stock rose so sharply this week is due to the thought that oil prices will remain at or above the current upper $50 a barrel level for a while. That's because OPEC and its partners agreed to continue holding back 1.8 million barrels per day from the market through the end of next year. This curtailment will help the market burn through its remaining excess inventory, which has been weighing on oil prices in recent years.

That said, even at current oil prices, Halcon Resources can't generate enough cash flow to fuel its expansion plan. In fact, the company doesn't expect to achieve cash flow neutrality until early 2020, and that assumes oil averages $55 a barrel along the way. The company plans on bridging that gap by borrowing money. However, that decision could come back to bite it if crude crashes, which is what happened a few years ago when a steep drop in oil prices caused the company to declare bankruptcy after it piled on too much debt by growing production.

The other problem with Halcon's plan is that it shows just how far behind it is from rivals given that several can currently flourish at $50 oil. For example, fellow Permian driller Concho Resources(NYSE:CXO) can fuel a healthy growth plan while living within cash flow at around that level. In fact, Concho has generated $440 million in free cash flow over the past two years even as it has remained on pace to boost production by a 20% compound annual rate through 2020. That ability to grow at a rapid rate while living within cash flow at lower oil prices makes Concho a much safer bet, especially in light of Halcon's run up this week.

Image source: Getty Images.

Dirt cheap cash flow

While Enbridge Energy Partners struggled in recent years, it is on a much stronger financial foundation right now. The oil pipeline company noted this week that it expects to produce between $775 million to $825 million in distributable cash flow next year. That's enough money to cover its 9.5%-yielding distribution to investors by a comfortable 1.2 times. Further, thanks to in-process expansion projects and acquisition opportunities in the pipeline, the company expects cash flow to steadily increase through 2020. That leads Enbridge Energy Partners to believe that it can grow its already generous payout by a 3% annual rate over that time frame.

That forecast suggests Enbridge Energy Partners could be an excellent stock for yield-seeking investors to consider. However, it also shows just how cheap the company's valuation remains even after this week's pop. At the mid-point of the current guidance range, Enbridge Energy Partners sells for less than nine times cash flow, which is dirt cheap for a pipeline company since most sell for a mid-teens multiple of cash flow. That could mean Enbridge Energy Partners still has room to run as it catches up to its peer group.

Get paid while waiting for the market to realize its mistake

Buying Halcon Resources is a high-risk gamble -- even more so after this week's pop -- because it needs oil to remain at or above $55 per barrel for the next several years to fuel its growth plan. Enbridge Energy Partners, on the other hand, doesn't need any help from OPEC or any other source. Because of that, investors can collect a near double-digit yield while they wait for the market to wake up to the fact that it still sells for an absurdly low price even after this week's surge. That clearly visible upside makes it almost too tempting to pass up.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Author

Matthew is a Senior Energy and Materials Specialist with The Motley Fool. He graduated from the Liberty University with a degree in Biblical Studies and a Masters of Business Administration. You can follow him on Twitter for the latest news and analysis of the energy and materials industries: Follow @matthewdilallo